Benefits And Costs Of The SEC’s Proposed Climate-Related Disclosures For Investors

The SEC has released its long-anticipated proposed climate-related disclosures for investors. While much has been made of the trade-offs and first-order impacts, a close reading of the 500-plus pages suggests a longer-term problem. The back-door approach called for by the proposals is unlikely to work.

The most glaring concern is that the commission is unable to quantify the benefits for society, while conceding that the costs to companies in terms of compliance and more accurately measuring emissions, as well as to the SEC itself, will be in the millions. Implementing the new disclosures and monitoring compliance will not come cheap, and the SEC will need additional funding from Congress if it is to morph from financial regulator into the economy’s main environmental cop.

Companies are already required to disclose material climate risks to their businesses. Other disclosures related to ESG—shorthand for using environmental, social and governance criteria to guide business decisions—are currently voluntary and amorphous in nature because the definition of “good” ESG has not been settled. The proposed regulations, which lean heavily on the environmental component in ESG, will do little to change that.

The SEC has been concerned with the governance component, which can cover everything from who sits on the board of directors to how internal decisions are made, for years, with varying degrees of success. In reality, the agency consistently relies upon investors having enough sense to look after their own interests. S, the social component of ESG, is absent from the SEC proposal. “Social” focused disclosures have been downplayed with this recent effort: with more than 2 billion humans joining us on this planet over the next 30 years, the ability of humanity to provide food and iPhones to them will necessarily increase greenhouse gas emissions. U.S. companies are unquestionably the global technological leaders in agriculture and energy, and they need access to capital provided by the most liquid and transparent capital markets in the world. G will determine the tradeoff between E and S in pursuit of earning returns to shareholders.

Are further disclosures necessary for fossil fuels companies? We know how much coal, oil, and natural gas they sell, and we, or any high school chemistry student, can calculate the associated emissions.

What justifications have been offered for the obvious costs of complying with the new disclosure rules? The stated reason is that investors are clamoring for these new climate disclosure rules. Recent polling, however, suggests otherwise. In February, Broadridge released a new 2021 ProxyPulse report that analyzed the voting behavior of retail and institutional investors from over 4,000 public company annual meetings in 2021. The report found that retail investor support for environmental and social proposals in 2021 was less than half that of institutional investors, at 18% vs. 40%. This divergence makes sense because the two groups have different incentives: retail investors seek to maximize their financial returns, while institutional investors seek to maximize their revenue, through product offerings—like ESG-directed private equity funds and mutual funds—that obtain higher fees. When the SEC claims to implement policies in the name of investors, they should be clear who they mean. It’s not the individual investor.

Thankfully for retail investors, consumers and businesses, procedures already exist in U.S. administrative law to check the effects of this sort of miscalculated rulemaking. A cost-benefit analysis has been required of proposed federal rules and regulations in one form or another since the Johnson administration. On page 349 of the proposed climate rule, the SEC states:

In many cases, however, we are unable to reliably quantify these potential benefits and costs. For example, existing empirical evidence does not allow us to reliably estimate how enhancements in climate-related disclosure affect information processing by investors or firm monitoring.

Indeed, the next 70 pages of the proposal cites dozens of indefinite “studies” as to possible benefits and costs. Noticeably absent from the cost studies is any study broaching an estimate of what economy-wide, mandatory climate disclosures may reasonably cost in practice. Without that, the proposal is indefensible.

The SEC does acknowledge that the imposition of the new rules will invite new litigation against public companies. Litigation costs will no doubt exceed the additional costs of compliance. The SEC offers a “safe harbor” exemption from such litigation, which sounds good. However, everyone in the revolving doors of the SEC universe knows that claiming and defending a safe harbor exemption occurs only after a lawsuit has been filed. Apart from creating a new sub-industry of SEC litigation, the acknowledgement of this potential cost echoes the vigilante enforcement mechanism of other poorly worked policy proposals, highlighted by Texas’ most recent abortion restrictions, which allow any outside party to sue abortion providers or others accused of breaking the law, rather than calling for the state to enforce the law directly.

While a sloppy analysis of costs and benefits will no doubt weaken the SEC’s hand when the rule is eventually challenged in court, the reasons this proposal has been fast tracked are well known in Washington. With his environmental agenda stalled in Congress, President Biden has turned to regulation to enact policies to reduce emissions.

The Biden administration has taken up where the Obama administration left off on climate policy. The Waxman-Markey climate bill passed the House in 2009 but failed in the Democrat-controlled Senate. From that moment forward, Democratic leaders have attempted to achieve their climate goals via the unwieldy tool of agency-promulgated rules and regulations.

A better approach would be to enlist allies from industry. For more than 10 years, the major oil companies have testified and lobbied in favor of a carbon tax. Applying a carbon tax at the wellhead, the mine-mouth, and the port-of-entry for imported hydrocarbons will push the costs of carbon-intensive activities from the beginning of the supply chain straight through to the ultimate decisionmakers, the consumers. These are the decisionmakers that have made the Ford F-150 truck the best-selling vehicle in America.

On climate, President Biden would do well to embrace the leadership example of President Jimmy Carter, who knew that his appointment of inflation hawk Paul Volcker as chair of the Federal Reserve during the stagflation crisis of the 1970’s would likely mean a one-term presidency. Volcker raised interest rates. A recession followed, and the persistent inflation that had plagued the U.S. for 20 years was over. A similar, politically bruising series of tradeoffs awaits the U.S. on climate. Naming, shaming, and measuring in the public markets will not scratch the surface of real solutions.

If the goal is to reduce greenhouse gas emissions, attack the problem directly in the consumer market. Impose a carbon tax. Just do it.